Final Quarter Expectations

by | Sep 30, 2020

Uncertainty continues to grip markets. The path of economic recovery is less clear than ever. Rolling secondary waves of infections coupled with the risk of renewed lockdowns, political uncertainty due to Brexit and the U.S. elections, the fiscal cliff that the U.S. faces and the ever present tension between China and the U.S. make for a complex decision tree. As we move into October, we look at the expectation for the final quarter of 2020. Let us consider the positive forces underpinning an economic bounce. Firstly, in the U.S. the new-orders-to inventories ratio is improving. This shows that inventories of finished goods have sharply declined in the past six months meaning that the economy is making up for the collapse of both spending and production in the first half of this year. Similar dynamics are occurring in other parts of the world like China, Europe and Japan which suggests – that manufacturing activity is rebounding due to an increase in demand for goods. See figure 1.

Secondly, China embarked on an aggressive stimulus campaign in response to the economic fallout following the pandemic. These policies are generating economic stimulus which will filter through the global industrial and commodity sectors and be a crucial boost to the global business cycle.

Beijing’s unconstrained credit easing (the action by a Central Bank to make credit and liquidity more available to financial institutions, often through the process of expanding their balance sheet) is the source for the turnaround in China’s expenditures outlook. This sharp increase in China’s credit and fiscal impulse foreshadows a powerful rebound in imports and in global industrial production because Chinese capital expenditure creates powerful demand for commodities, industrial goods and capital goods. See figure 2.

The policy response from Governments and Central Banks following the economic crisis has been rapid and vast. Governments have racked up their largest budget deficits since World War II. Central Banks moved quickly to ease financial conditions through lowering interest rates. The growth in broad based money supply among advanced economies has surged with global corporate bond issuance standing at a record $2.6 trillion. Increasing liquidity points to continued industrial production strength, and the increase in emerging market carry trades (a metric which shows whether funds are flowing into emerging market economies) all point to improving global growth. See figure 3.

Unlike the fallout following the Great Financial Crisis, where consumers’ balance sheets were destroyed following extremely dangerous levels of household debt and the collapse of the housing bubble, debt levels are relatively low and the impact of the crisis on net worth has been slightly more limited. This has allowed expenditure by households to rebound faster than what investors initially anticipated.

Three near term concerns still hang over the global economy and while quarter three should deliver strong numbers, growth in quarter four is likely to recede. Household consumption is an important harbinger of growth particularly in the U.S. The fiscal cliff facing the U.S. brought about by Washington’s inability to finalise the stimulus bill is an immediate threat to this. The numbers suggest that households were able to save a large portion of these benefits which allowed consumption in August to remain strong. However, households cannot continue tapping into savings forever. Although employment figures have rebounded from the lows of April and so looks positive, the metric hides the number of permanent joblessness. In the U.S the number of permanent job losses have quickly reached 4.1 million last month and continuing unemployment insurance claims are barely declining. We will see similar results in other major economies like the U.K. and Europe whose labour market has until recently been supported by government schemes, but which is disappearing.

Lastly, as winter approaches in the northern hemisphere and people are forced to congregate inside, the likelihood of second waves of infections and therefore stricter lockdown restrictions remains high. This remains the greatest threat to any meaningful economic recovery. Services sectors particularly in leisure, food, hospitality and travel remain the hardest hit. Although these sectors account for a relatively small percentage of GDP in some countries (like the U.S.) they are big employers. Other countries who are extremely reliant on these sectors face an even bigger drag on GDP. Ultimately the forces driving the recovery will be greater than those which hamper it. U.S. authorities will have no choice but to add supplementary fiscal stimulus to the economy which will be in the region of $2 trillion. Either weaker stock prices or a deterioration in the economy will be the catalyst for Washington to strike a deal. Monetary conditions are also set to remain extremely accommodative in many economies which eases the pressure on business and the consumer.

The recovery in the final quarter is likely to slow off the pace of quarter three but spending will power ahead next year and so we should see growth pick up into 2021. In an environment of improving global growth, emerging market currencies like the Rand as well as major currencies like the Euro and Pound as well as commodity linked currencies like the Australian Dollar will gain versus the Dollar. We would expect conditions to favour emerging market currencies over the coming months, and the Dollar to continue to sell off, despite short term corrections in the value of the Greenback.

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